Are you getting financial SaaS wrong?

In the 1990s, the airline industry in Europe was liberalized. Ryanair and EasyJet disrupted the market by introducing dynamic seat pricing and a faster plane turnaround time. Across the pond, Southwest Airlines was bringing about a similar change in the US market. They reduced fares significantly and made air travel accessible to a large portion of the population.

Their success didn’t come from stealing market share as much as it did from creating demand. These airlines outsourced a number of activities to external service providers and created value.

(Source:?Oliver Wyman)

The impact of this shake-up is evident today, even in India. There are countless booking-focused third parties that help airlines secure reservations. Catering is outsourced to reputable hospitality players. Even aircraft are often leased instead of being purchased.

Financial services is having a similar moment -

All operational functions of a credit provider can now be unbundled into separate modules.

Such a fragmentation of financial services has been perceptible on the front-end. Customers are no longer restricted to the suite of services available at their bank. There is ample customer education about start-ups that specialize in and provide individual products or services bundled by their banks.?

In fact, banks are themselves partnering with these new age players to integrate specialized services into their own offering. This has given rise to a few banking business models –?

1. A?fully digital bank?with cutting edge tech for better customer experience at a cheaper price
2. A digital-only?banking marketplace?that aggregates a wide range of third-party products.
3. Banking-as-a-service?tech companies in partnerships with banking license holders that provide B2B services.

But what I’m interested in, for the scope of this piece, is the disassembling that has been going on at the?back-end.?

Atomization of the value chain

The value chain of a financial services provider is made up of?primary activitiesand?support functions. All these activities jointly create business value, but only the former are central to the business. In traditional financial services, this value chain was vertical and all aspects taken care of in-house.

But now, the value chain is becoming not only horizontal, but also atomized.?

A number of these functions - both primary and ancillary -?are fractured from one another and outsourced to third parties. The market is crowded with software providers with expertise in niche services like authentication and identification, KYC, human resource management, and even central functions like underwriting, credit scoring, data analytics and fraud detection.

The benefits of this evolution of the value chain aren’t lost on anyone. These outsourced services are:

1. Customizable?with a number of features and combinations of these features on offer,?
2. Flexible, and hence highly scalable apart from being easily turned on and off; and?
3. Turnkey, in that they require little integration and are enabled by APIs, cover a particular service end-to-end, and are priced in keeping with scale.

Readily available SaaS products for every fathomable function within the value chain have allowed financial service providers to reduce their investment in acquiring these capabilities, enabling them to pivot from spending on capex to opex. For these reasons, they are attractive, ubiquitous,?and?essential in an increasingly competitive financial services sector.

So, notwithstanding the bleak economic outlook and?setback?to investor funding, financial service providers must tighten their purse strings and spend sparingly on acquiring these capabilities. They must reckon with the?mission criticality?or?expendability?of each piece of software.?

Not all SaaS is created equal

How do you make trade-offs between ‘must-have’ and ‘nice-to-have’ SaaS products? The distinction goes beyond whether they simply fulfill primary or support functions along the value chain.?

Mapping each function to mission criticality or expendability is an exercise governed by every individual organization’s priorities. For instance, if revenue generation is front-and-center on the agenda, here’s how a lender may rationalize their SaaS purchases:

But for most, revenue isn’t the only driver of purchasing decisions. There are a number of overarching factors to consider. In my experience, partnership priorities come down to:

• Business fit?

The textbook definition of ‘mission critical’ – how central is a piece of software to your core business? In digital lending, some of the indispensable functions outsourced would include:

These are made ‘mission critical’ by the fact that if these tech providers faced a downtime, the host would face a material disruption or have to halt operations. Where such a product fits into the business also determines its pricing, product stickiness and expendability.?

Onboarding, underwriting, loan origination, payment acceptance and collections software are crucial to the digital lending business just as the Google Maps building blocks are absolutely essential for Uber. The SaaS product’s proximity to the nucleus of the business, therefore, determines whether a lender should invest in it or not.?

• Are you in the right customer set?

A particular SaaS product may be serving only a tangential purpose, often because the digital lender was not the target group for it. Take Substack or HubSpot for example - I use it to share my thoughts on things I find interesting. But was it built keeping the CEO of FinTech company in mind? Probably not.

Here’s a more interesting example – Spade, a US-based FinTech offering universal transaction enrichment, would have been started with the idea of enabling budgeting and personal finance management, but it was just a tool that enhanced the UX for these apps.

But Spade realized that its core capabilities were more than a dispensable side-benefit of having a good UX. Its ability to source new information about customer transactions could become a permanent fixture in cash flow-based underwriting tools.

A financial services provider can determine whether it is the target audience for a product by asking themselves one simple question – will buying this product affect their top line or bottom line?

• Competitive advantage

Specialized SaaS products that tackle specific problems can give the lender a business advantage. The trick here is to identify a tangential function which could potentially contribute to revenue.?

For instance, a lender is likely to have its own risk assessment suite in place. They may have access to bureau scores and tools that help access important financial information like bank statements.?

Integrating the capabilities of an intelligence provider would help bring in alternative data insights to fortify credit decisioning and unlock new (poorly served) market segments and a bigger business opportunity.

• Future roadmap

Reevaluating SaaS partnerships is common among companies trying to pivot away from their initial positioning. Say, an e-commerce platform has partnered with a BNPL provider. But in the future, it intends to build a?serious revenue stream?through offering credit. For this, the platform might want to scale up BNPL and also move towards larger financing products.??

Now, the platform would prefer that the end user-facing financing journey is unique, in-app and carries its own branding. At the same time, it would also like the flexibility to tailor specific parts of the lending journey depending on its product offering and the borrower pool it caters to.?

It makes sense for the platform to enter into conversations with other white-labeled infrastructure providers at this juncture. Foresight when it comes to the direction in which the organization is headed is crucial in determining the critical areas that require specialized third-party intervention.

• Relative efficiency of current and future solutions

Perhaps there is a new SaaS product out there that is more efficient than the current solution. It could be faster, cheaper, or easier to integrate with and maintain. Such a disruptive force would have to command a better ROI for the financial services provider to switch.

• Value beyond money

Some products or features may be worth purchasing notwithstanding their ability to directly generate revenue or profits. These may have other merits - like the addition of stickiness. For example, integrating an account aggregator functionality to fetch financial information even in non-financial products (like an employment verification service, for instance) can reduce touchpoints in user journeys and improve customer experience. Ultimately, this has a positive impact on product stickiness.

Likewise, there are countless features in the market that can introduce better network effects or even help create ramps for future product launches.?

• Regulatory compliance

Regulation of FinTech and digital lending is still under formulation. This exposes players in the space to unforeseen risk and necessitates stability of the underlying infrastructure. Introducing regtech products – extraneous to core priorities –

can enhance compliance with domestic and global regulations.?

Stress testing the current infrastructure across edge cases reveals addressable vulnerabilities – a first step in the right direction. In the long run, regulator compliant?SaaS stacks become critical to the business.

I’ve written about the indispensability of regulatory safeguards in more detail?here.

Conclusion

Unbundling created a culture of hyper-specialization of financial and support services. It may be criticized for flooding the market with solutions for problems of all degrees of urgency.?

However, this very volume of and velocity at which SaaS solutions are released has forced financial service providers to reckon with their most pressing priorities. The result? Better fleshed-out operational structures, keener focus on spending and ROI, and limber organizations.?

As the silos break and architecture of banking shapeshifts into lego-blocks of modular fintech services, it’ll be a matter of time before hyper personalization and hyper scaling go from mutually exclusive to perfectly synergetic. I am excited!

Written by Rajat Deshpande