We asked our friends at Simon-Kucher & Partners, experts in top line revenue growth to share their deep expertise in the embedded finance industry. Read on to find out more about:

1. The latest dynamics and key trends in the industry fuelling growth
2. How embedded payments can help accelerate growth and provide a more compelling experience to customers
3. Best practices for introducing embedded payments into an integrated offer for customers
4. Tips and tricks to optimise pricing and ensure you remain aligned to customer needs

The global payments market has been growing at a double digit rate and is projected to exhibit a 12.3 percent CAGR in the next five years, with both point of sales and e-commerce channels seeing growth.

‍Dynamics fuelling the growth

A few notable developments have triggered changes along the value chain, leading to a shift in expectations of merchants and customers.

1. New players enter the market…
   Spotting gaps in how incumbents served the market – notably in the SMB segment and companies operating in multiple countries – new entrants have been able to enter with a clear proposition, solving the pain points experienced by merchants.

2. … with an ecommerce advantage
   The rise of e-commerce has created further opportunities for new players to target a high-potential market. With incumbents typically stymied by their legacy infrastructure to offer an e-commerce proposition and then a unified omni-channel offer, new entrants have been able to get ahead.  

3. Regulatory changes have made it easier to enter the market …
   Regulatory changes and scrutiny have also had their fair hand driving the trends. Opening of the market (e.g., open banking, allowing non-banking companies to offer payment services) has made it easier for more companies to enter and service merchants and end customers. 

4. … and also resulted in vertical consolidation
   Meanwhile, regulatory burden and restrictions (e.g., PSD II, interchange caps) have compressed margins, leading to vertical consolidation in the value chain – often with incumbents buying the new entrants or even larger new entrants buying smaller ones! This has meant companies can offer a wider array of services to merchants under a one-stop-shop method rather than merchants sourcing individually from multiple companies.

5. Merchants are in a stronger position
   These changes have led to more options for merchants and increased expectations while lowering the cost-to-serve from increased competition. Lower margins have further accelerated developments from players to offer value added services (e.g., turnover based financing, fraud protection services). This enables them to differentiate themselves and enhance their revenues directly (by charging for these services) or indirectly (through higher prices on payments) and encouraged more merchants to move from cash to digital payments. 

6. Pandemic has permanently changed behavior
   COVID-19 provided yet another push to digital payments with lockdown forcing customers toward e-commerce on the one front, while fear of infection from using cash drove customers and merchants further toward digital payments. While many pandemic restrictions are now  lifted, the change in merchant and customer habits are expected to stay. 

7. New technologies enhance the experience
   The internet and tech boom over the last decade has further enabled new offerings for customers. WeChat Pay is a prime example of how a chat/text app has evolved into a popular means of payment, first starting as a P2P method and then as a C2B one. Similar examples – large and small – are abound across the globe where technology has changed how customers make payments, making the process smooth and embedded into a wider customer experience. 
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Embedded payments

All these factors combined have shaped the current landscape, where payments are becoming an embedded part of the customer journey. Hence the term “embedded payments” – and with the inclusion of the broader set of financial services – “embedded finance”. In simple terms, embedded finance is the offering of a financial service to customers by a non-financial organization as a by-product of the software or services used. 

Uber provides a very intuitive illustration of embedded payments at work. When you finish your ride, you don’t have to hand over cash or put your card into a terminal as you would with a regular taxi. The payment is automatically taken from the payment method saved on your account in the Uber App. The taxi driver also doesn’t have to worry about non-paying customers, handling cash (esp. change), or getting a card machine and signing up with a payment processor and acquirer. In this sense, payments are embedded seamlessly into the customer experience so that the customer doesn’t even realize it. With UberEats, the illustration expands to include delivery personnel and restaurants – you don’t even have to think about making a payment – all are made directly by Uber to the respective parties. 

There are a couple of reasons why companies are embracing embedded payments and broadly embedded finance: 

1. It helps acquire customers, especially in industries where competition is intense
2. A seamless experience increases customer satisfaction and stickiness, compensating the high costs and heavy promotions needed to acquire new customers
3. It increases customer life-time value as “transacting” with the company is made simpler, with customers more likely to make repeat purchases
4. It provides additional data that can be used to provide more relevant offers and services to the customer, further enhancing the above 
5. It creates additional revenue streams – indeed, revenue from these solutions can even surpass the revenues from non-payments or finance products!

It’s not just about companies and merchants. End customers also benefit in the form of enhanced interaction and purchase experience, better financial inclusion, and more competitive offers.

Equally, with companies able to negotiate better pricing due to scale, it effectively means that customers get lower prices than they would if they interacted with each party separately. An owner-operated cab might pay a mark-up to its payment processor in the region of one percent while Uber would pay its processor under 0.05 percent. 

A compelling example of customers benefitting from embedded payments is turnover-based financing for merchants. With better visibility of the merchant’s everyday turnover, a payment processor can make more informed decisions on lending and recover funds more easily by retaining a share of funds processed. This is a blessing for small merchants that may be locked out of working capital from formal lending institutions and/or have to pay much higher interest rates.

Best practices for introducing embedded payments

With all these evident benefits from embedded payments, what does it take for a business to provide such an offer, and what additional factors need to be considered? 

Determine the offering

Start by identifying what makes sense for customers. It is imperative to figure out the customer pain points you want to solve and to assess the adjacencies and value add of the underlying business. The contemplated proposition needs to be logical for the core customer groups and be fit for purchase alongside the existing products/services of the business.

Equally important is to figure out which payment methods to offer end customers as these differ by geography and have a direct impact on customer conversion and repeat usage. For success in e-commerce in Germany, PayPal and Sofort are important. Just across the border, iDeal in Netherlands, Twint in Switzerland, and Swish in Sweden would be required instead. These varying needs by market also require check-out to be optimized not only for which payment methods are shown in which geography but also in terms of the order in which they are shown. Not doing so will have consequences on both conversion and costs.

‍Establish the route to market

In tandem it is important to determine how best to operationalize the offer: whether to build, buy, or partner?

A single payment transaction requires multiple parties for successful execution. Adding to this complexity, each payment method has its own infrastructure/rails. If that were not enough, there are regulatory (e.g., license, data protection) and compliance (e.g., anti-money laundering, sanction checks) elements that need due care and can have drastic consequences.

Businesses typically start by partnering with existing providers to quickly get the benefits. Then, as they scale, they start in-sourcing certain parts by either buying smaller providers or building in-house capabilities.

A clear line of sight from the start helps reduce the risk of embedded finance becoming a cost drag, or worse, an unmanageable beast. 

‍Set up an integrated offer for customers

Embedded payments and finance deliver results when they are fully integrated as a part of the core offer to customers. Providing these on the side as an also-available solution vastly diminishes the realizable benefits. 

Consider whether payments features and functionalities should be packaged as a part of the existing core platform, as a tiered offering (e.g. good/better/best), or as an à la carte add-on. A key consideration here is that the packaging drives payments volumes while also aiding the adoption of the core product/service.

With the majority of businesses, the payments component would be monetized through the total value of transactions and/or the number of transactions. It is usually so because the cost structure of payments is typically different from the underlying business and scales with payments volumes. This implies the more volume, the better for business. Consequently, the packaging approach should tilt to including payments as a part of the core offering to facilitate more volume. 

Another key consideration is keeping your customer segments in mind. In both retail and SMB segments, offer simplicity is crucial for success. When catering to larger businesses, a more sophisticated approach would align with the need for a competitive offer and transparency for managing costs.

Ensure pricing is aligned with customer needs 

How you price is often a lot more important than the actual price levels. On this topic, the underlying metric (i.e., basis on which you charge your customer) and the model (i.e., how the metric scales) need to be well thought through. The metric and the model should both be aligned to the value of the solution and the cost. The value may indeed differ by customer segment – knowing the needs and preferences of the target customers should form the foundation of pricing metrics and models, with flexibility required for negotiated deals. This is true not only when it comes to payments, but also for the core solution of the business. 

Our research indicates stark differences in customer preferences. In the example below, merchants with different transaction profiles chose vastly different price metrics even though all options led to the same outcome! These differences are not minor, and indicate that pricing fit is critical. 

In an ideal world, the metric and models for payments blend with the metric of the underlying core product itself. This may not always be possible as value and costs may diverge. In these scenarios, there should be a clear understanding within the business that is translated into effective customer communication, justifying dual metrics and models.

Leverage the attention on ancillary fees smartly

Besides the core rate card for the embedded payments offer, there will be ancillary charges (e.g., chargeback fees, failed transaction fees, cross border payments). Trying to blend all of these together may end up creating a distortion where the proposition is considered (often falsely) expensive while being beneficial to some customers and detrimental to others: double disadvantage.

Our research consistently shows that not all price items receive equal attention from customers. Attention also differs by customer segments – both individuals and businesses. A cross-border transaction may receive little attention from customers with few transactions, while customers who make transactions frequently will be more sensitive to the pricing.

A smart approach to charging for ancillary items is to think about which price items customers pay attention to, how relevant are the costs, and how much revenue potential they have for the business. 

As a general principle, items that are top of mind for customers should be priced separately. If the core payments pricing is competitive, slight premiums on these may be justified. For the low attention items, there is more flexibility – charge for them, if they can become a tangible revenue stream, or blend them in.

Summary

Payments volumes have been growing globally and will continue their trajectory for the foreseeable future. These trends have been fuelled by both demand and supply factors, ranging from market gaps, technological advancements, regulatory changes, to more demanding customers/merchants.

Payments now not only represent an important opportunity for companies but also an essential component for success. By embedding payments within their existing proposition, companies can develop an advantage over their competitors and unlock an important revenue stream.

Going down the path of embedded payments however requires due care and attention to multiple facets – starting from defining the strategy all the way to enabling the sales and customer success teams. In this paper, we have touched on a few of the components of Simon-Kucher’s framework for monetizing payments (illustration 9). Payment players as well as companies looking to offer payments proposition can use the framework to maximize the opportunity.