Enhancing Competitive Advantage in E-commerce Using BaaS and Embedded Finance

E-commerce has seen an incredible boom in recent years due to COVID. But even as the pandemic restrictions were mostly lifted across the globe, the conveniences of online shopping are here to stay, and the sector continues growing. Morgan Stanley predicts that the e-commerce market will grow from $3.3 trillion in early 2022 to $5.4 trillion in 2026.

On the other hand, the banking sector is seeing a decline amid rising interest rates, high inflation, and uncertain perspectives for business activity. The red warning light flashed bright in March 2023, as the 16th largest bank in the US, Silicon Valley Bank (SVB), collapsed after a bank run. Amid the rising panic, smaller players like Signature Bank followed. Even the biggest players cannot be regarded as safe anymore, as the Credit Suisse giant was recently taken over by its peer, UBS. The world’s banking majors like JP Morgan and Citigroup report profits shrinking by as much as 20%.

At the crossroads of these two major trends, the e-commerce boom and the banking sector turmoil — lies an opportunity known as Banking-as-a-Service (BaaS) and Embedded Finance. Rising tech companies are creating innovative products, like marketplaces and aggregators that, at some point, can leverage financial services.

Banks are seeking ways to boost their revenue and client base. Blending these needs is a win-win situation for both sides. According to McKinsey’s estimates, embedded finance market revenue reached $20 billion in the US alone in 2021 and could still double within the next three to five years. Another estimate by Juniper Research suggests that this segment would grow to over $187 billion globally by 2027, while BaaS platform revenues are set to reach $38 billion, up from $11 billion in 2022.

How it works

Digital life is becoming more and more complicated, so it is no surprise that customers are increasingly looking for all-in-one solutions. Brought to the pinnacle, this logic leads us to giant ecosystems, combining goods, services, and finance in one seamless experience. As early as 2020, the world’s leading companies were ecosystems.

The path to an ecosystem for the biggest players is obvious: acquiring their financial service providers and creating proprietary in-house solutions that would be tailored to the company’s internal systems and demands from the start. This was the strategy pursued by major retailers like Walmart and IKEA. In a lower league, the need for seamless solutions is satisfied by cooperation with BaaS providers to create an embedded finance experience for customers. Classic banks own and operate the entire value chain, from the banking license to engaging end-user B2B and B2C customers. In BaaS, the value chain is split between partnering companies, enabling them to focus on what they do best and make profits from it. There are four major models (and an infinite number of blends between them) of BaaS services:

• Providers offer their banking licence and products, operations, and/or technology for use by aggregators, other banks, and non-financial companies. One example of this model is Uber, offering its proprietary debit card to new drivers and delivery partners. With this card, they can instantly use money paid for the journeys they performed. Also, they can benefit from cashbacks and incentives from Uber partnering vendors. Another example is SoFi which offers investment products as well as loans in one financial super app. Also, clients can opt for a debit card issued by Bancorp to complete their finance management package. Providers benefit from BaaS by offering banking services to customers of distributor partners, scaling existing assets, and generating incremental revenue at a minimal cost.

• Providers-Aggregators act like Providers, but also lend their capabilities to other vendors to compose a complete out-of-the-box solution. Shopify is one example of this model, integrating small businesses’ accounts held at Evolve Bank & Trust with an e-commerce platform. Clients are offered debit cards and tools for monitoring their finances. Cash App by Square is another example, offering peer-to-peer payments, investment and cryptocurrency trade. Cards are offered via Marqeta and its banking partner, Sutton Bank. By aggregating other providers, provider-aggregators can offer integrated financial products, which can deepen relationships with distributors.

• Distributors leverage end-customer relationships to offer unique financial services propositions. This model is employed by global players like Facebook, Amazon, and eBay to integrate financial services into marketplaces and ecosystems; by Xero and Shopify to offer B2B services; by retail giants like IKEA, Macy’s and Walmart to offer point-of-sale lending, loyalty programs and co-branded financial services. Finally, it enables players like Wealthfront and Aspiration to offer digital banking and niche fintech services. In this model, providing banking services creates new value for customers, enabling distributor partners to strengthen their core business.

• Distributor-Aggregators enhance the propositions they distribute by adding new products or technology from multiple providers. For instance, Google Pay offers a digital wallet for conventional and online purchases as well as peer-to-peer payments. Also, it offers tools for finance monitoring and checking and saving accounts with several banking partners. The Lending Club enables small businesses to open and manage their accounts, including payment acceptance. Accounts are enabled by several fintech partners like Alloy for verification and KYC, Treasury Prime for lifecycle APIs and Marqeta for card issuance. By aggregating providers, these players offer the elevated experiences that customers are demanding; for non-financial companies this model enables them to distribute banking services without becoming a bank.

Choosing the right model and partner

The primary question is: how are you going to grow your business and what is the primary source of your income. Benefits do not distribute equally along the value chain, so it is important to find the right place in it. Most of it concentrates on the risk-bearing side of providers and on the customer-relationship side of distributors.

According to McKinsey research, the majority of revenues from embedded-finance lending products, 55% of the $14 billion in the United States in 2021, accrued to the balance sheet provider, the firm bearing the risk of credit default. However, with payments and deposits, it was the distributors who owned the end-customer relationship who benefited most. In lending, for instance, they earned $4 billion of the remaining $6 billion revenue pool, equal to 30 percent of total revenues.

Choosing the right partner among banks may point away from the biggest players. For banks with full-fledged proprietary delivery networks, embedded finance may pose a cannibalization risk. However, banks with a smaller retail presence, such as community banks and regional banks, may see it as a good opportunity to grow without making hefty investments in building their own sales funnels.

Another thing to keep in mind is whether you should choose to partner with a BaaS platform provider directly or opt for cooperating with a fintech intermediary to offer embedded finance. Samuel Head, head of EMEA banking sales at Currencycloud, a provider of cross-border multi-currency transaction solutions, suggests a simple rule of thumb.

“A company considering embedding financial services simply needs to consider how much ownership they wish to have. And what their end users’ needs are. In the main, if you are not in FinTech, find a FinTech company you can trust to embed a quality service that helps you sell more of your core product or service,’ Head told Fintech Global. “If you are a FinTech, think about using a BaaS supplier. It’s actually a good time to build in redundancy and to be very careful when selecting your partners.”