M-RCBG Associate Working Paper No. 247
Fintech Reimagined: Exploring the value of embedded finance for small and medium businesses
Anahita Sahu
2024 Policy Analysis Exercise prepared for Paypal
Executive Summary
Embedded finance (EmFi), which is the integration of financial services into the digital experience of a non-financial platform, has emerged as a critical solution for time-and-resource constrained small businesses (SMBs). This report, created for the client PayPal, a leading consumer fintech company, is a deep dive into the concept of EmFi and its relevance for small and medium businesses.
Motivating Question
So far, EmFi has primarily targeted Business-to-Customer (B2C) applications, like Uber payments or retail store credit cards. As more small businesses go online - 63% of SMBs now have an ecommerce presence1—they’re searching for integrated solutions to simplify operations.
Leveraging insights from fintechs, SMBs, government agencies, VCs and non-profits, this report examines the question: What is the value of embedded finance for a new customer segment, the small business? To address this question, it delves into (1) needs of US small businesses on the demand side, (2) risks & opportunities of EmFi and (3) and strategies for fintechs to succeed in EmFi on the supply side.
The Problem
Nearly half of US small businesses fail within the first five years due to a lack of integrated digital solutions and financial management support. Small businesses who drive the U.S economy, representing 99.9% of all businesses and accounting for 40% of GDP2 still struggle to access credit and tailored technology solutions in a fragmented digital landscape.
Key Findings
EmFi presents an opportunity to address some of these pain points by embedding financial solutions into a small business’ daily workflow. Unlike traditional digital solutions which rely on multiple platforms, EmFi facilitates a one-stop-shop experience for SMBs to oversee financial functions like payments and perform business tasks like inventory from a single, central hub.
While the embedded finance market, projected to reach USD 7.2 trillion by 2030, gives access to the small business customer segment in a way that didn’t exist before, it also raises new questions around financial regulation and data sharing and privacy.
Key findings include:
-Small businesses are a challenging customer segment, not easily defined by single qualifiers like revenue and number of employees. Diverse ownership, a lack of reliable public information and limited insight into what goes on in the day-to-day of a small business makes it difficult to neatly categorize a small business by just their yearly revenue or team sizes. For example, a roofing contractor with annual revenues of USD 16.5 million and an asphalt manufacturer with less than 750 employees are both considered a small business.3. This diversity creates an information gap on what SMBs need and when they need it.
-Like most financial technology innovations, embedded finance offers large benefits at a cost to small businesses. EmFi unlocks access to capital and operational efficiencies by offering customized solutions when, where and how a small business needs it. However these solutions can be expensive and are powered by processing and sharing large amounts of small business data, which raise privacy and security concerns.
-EmFi offers a new way for fintechs to engage with small businesses, but also dilutes the customer-provider relationship. While EmFi enables fintechs to unlock a new customer segment without the acquisition costs and need to build financial infrastructure, it also introduces challenges in maintaining customer relationships and adapting to increased regulatory scrutiny as the lines between a technology and financial company increasingly blur.
-Personalization is the future of embedded finance. The future lies in building strong customer relationships by offering ultra-personalized services that meet the immediate needs of an SMB. To succeed in the evolving landscape of embedded finance, incumbents must adopt a strategy of collaboration with fintechs, leverage data for personalized service offerings and continually innovate to meet the specific needs of SMBs.
Bottom Line: Embedded finance shows great promise for empowering small business success
The value provided in enabling highly-personalized financial management solutions tailored to highly-diverse needs outweighs the risks posed to small businesses. With EmFi, small businesses know exactly how much cash they have left at the end of the month, or where to get a quick loan, so fewer good businesses fail and more have the confidence and resources to succeed.