In spite of recent economic turmoil, the payments industry has shown remarkable resilience and growth – global payments revenues declined by only 2.5% from 2019 to 2020, and are predicted to reach $2.9 trillion by 2030. However, payment service providers will have to evolve to keep up with new headwinds, with increased competition, rising interest rates and new business habits. In the quest for new income streams and competitive advantage, embedded finance could be the future of their revenue models.
Embedded business lending will grow 5x over the next five years, from $0.2B to $1.3B by 2026.
Growth challenges for payment service providers
The payment industry has been working with favourable market conditions for much of its recent growth phase. Key to the success of payment service providers have been a low interest market credit, the rapid expansion of international e-commerce and increased digitisation of payment networks. Together, these have helped businesses and consumers spend more, in more markets, while relying on digital platforms to facilitate their transactions.
Moving forward, payment providers will have to confront a high inflation, high interest environment, putting additional pressure on their business models. This could include a drop in revenue as consumers and businesses shift balances away from transaction accounts to other deposit vehicles in pursuit of higher rates or reducing spending across the board, leading to less transaction revenue for PSPs.
In this complicated environment, PSPs will need to find ways to reduce their customer acquisition costs (CAC) and improve retention, while preserving and growing their top-line revenue. Recent expansion means that many PSPs still have valuable customer networks of engaged users and a route to market for offering new services – the question is what to offer.
Embedded finance and credit for payment service providers can provide a new way to not only monetise existing relationships but also build stronger connections with customers, while distinguishing their services in a crowded market.
How does embedded finance work for payment platforms?
Embedded finance is a rapidly growing segment of the financial services industry, with the UK’s embedded finance industry growing 33% in 2022. In practice, this can refer to any business that chooses to provide financial services and products to their customers alongside their existing offering.
For payment platforms, embedded finance can enable them to go beyond facilitating transactions to offering additional financial services that complement and expand their products to create new revenue streams and increase retention. Leading providers such as Stripe have already taken this step, implementing additional services such as credit cards, lending and accounts alongside their existing payments product to diversify their revenue streams.
Why are payment platforms suited for embedding finance?
Payment platforms are built on making connections – starting with facilitating transactions between merchants and customers, managing the financial ties with both parties to move funds quickly and securely.
These links provide a valuable foundation to offer additional transaction and liquidity-based services, based on their users’ needs. Embedded finance enables payment providers to offer fast and flexible revenue-based funding to their merchants alongside payments, leveraging unique strengths of their position.
In comparison to traditional lenders, such as banks, payment providers are able to provide a better, more efficient lending experience due to:
- Pre-existing customer relationships with business customers in need of financing
- Presence at POS when finance is needed
- Integration with financial infrastructure for merchants to provide funds
- Access to previous transaction data to assess credit risk
- Integration with accounts to facilitate repayment
Implemented correctly, embedded finance could see payment platforms become the natural lending partner for SMEs and merchants, providing timely, specific, data-driven finance solutions at POS to facilitate larger, more numerous transactions while driving value for customers.
What are the benefits of embedded finance for payment platforms?
In an increasingly competitive market, embedded finance and revenue-based financing create a range of advantages for payment providers, including:
- The ability to create new owned revenue streams, independent of the existing payment value chain
- Increased customer retention, with 75% renewal rate amongst funded merchants
- Differentiating payments experience from single-service competitors
- Increased CLV based on additional revenue per customer
- The chance to power growth of merchants, thereby growing transaction volumes and core processing revenues
- Using lending to source financial data to tailor payment services
Combined, these provide the tools for PSPs to increase resilience, revenue and agility in the market, supporting merchants to create more valuable long term relationships.
How can payment platforms use embedded finance to increase revenue?
In traditional models, payment revenues are largely based on a Merchant Discount Rate (MDR) charged to merchants ranging from 1% to 3% of the transaction value. The MDR is then distributed across the value chain alongside other stakeholders.
Financing creates a new value stream for payment providers that is unique to them, with no need to share revenue with other value chain stakeholders. PSPs can earn a commission every time a merchant is successfully funded on their platform (up to 20% of loan value in some cases). Crucially, funding is a unique value stream, with a one-to-one relationship, excluding other stakeholders in the transaction journey, meaning the PSP can keep the revenue it generates while also taking advantage of other embedded finance products such as instant payouts to further grow core revenues.
Finding the right partner for embedded finance
When implementing embedded finance, PSPs face the choice of whether to build their own financing offering or partner with a third-party provider. Working with a partner offers advantages for PSPs in deploying funding for their customers, including:
- Faster go-to-market: With a partner such as YouLend, PSPs can deploy a solution in as little as 7 days, launch pilots and test the new solution quickly
- Reduced risk and cost: Working with an expert provider helps PSPs save on development time, costs and in-house resources by implementing a single-API solution
- Capital preservation: Partnering with an embedded finance expert prevents the need for PSPs to use their own capital, which keeps the lending risk off their balance sheet
- Brand preservation: Third-party solutions can be white-labelled to offer services within the PSPs own-branded environment which help improve the customer experience and brand presence
What’s next for embedded finance and payment platforms?
As digital payments move to being the default transaction pathway for the next generation of business, payment services providers will need to find new ways to retain and grow their customer base. With embedded finance growing fast, it’s likely that in the near future, funding from payment platforms will likely become a ‘standard’ service, expected from all providers.
Businesses who can move first have the chance to serve their customers with confidence, unlock higher merchant retention and new revenue streams while testing, optimising and scaling their funding products.
YouLend is an experienced funding partner for leading PSPs with experience in integrating, launching and scaling embedded finance products for payment platforms. To find out more about the value we can provide to your business and customers, check out our PSP case studies here or book a demo with one of our embedded finance experts.