Is Embedded Finance the answer to Embattled Consumer Fintechs’ Profitability Woes?

THE HARSH REALITY

In recent times, we have witnessed a plethora of consumer FinTech start-ups come to the fore, gobbling up vast swathes of customers to take on legacy banks and other traditional financial services providers. Yet, how many of these consumer FinTechs actually possess a viable business model with sound economic fundamentals?

Statistics show that 75% of FinTech start-ups shut shop within two decades,1 clearly signalling a lack of financial sustainability that haunts the industry.

A key component that underscores the poor unit economics that plague consumer FinTechs is their customer acquisition cost (“CAC”), i.e., the amount spent by consumer FinTechs on acquiring a customer. In 2020 alone, finance apps splurged a whopping USD 3 billion on acquiring customers.2Splashing such an exorbitant amount of cash on a marketing blitz to quickly build-up a customer base has resulted in FinTechs incurring an eye-watering inorganic CAC of USD 1,202 on average.3 Against this backdrop, the question that arises is what do FinTechs have to show for spending such lofty sums on acquiring each and every user?

To begin with, around 35.5% of their users end up uninstalling the app.4 Ergo, more than a third of the capital allocated towards bringing these users into the fold ends up getting wasted. Quantifying this wastage, more than USD 80,000 is lost on a monthly basis on acquiring users that simply uninstall the app without generating sufficient value to cover the cost being borne by FinTechs to acquire them.5

Already being put on the backfoot, the onus then falls on the FinTechs’ ability to adequately monetise the users that continue to stick with them. However, with an average revenue per user (“ARPU”) of USD 84 in emerging markets and a few hundred in developed markets, many FinTechs’ unit economics are commercially unsustainable.6 With their lifetime value to CAC ratio (“LTV/CAC”) in the doldrums, a far cry from the 3-5x multiple that is typically desired,7 it is no wonder that so many FinTechs are losing money and going bust.

As such, given their cash guzzling nature and underwater unit economics, consumer FinTechs are bound to turn to external sources of funding, such as venture capital (“VC”) investment, to quench their thirst for cash. However, while these FinTechs may have been propped up by VC money thus far, that source of financial support now seems to be on the wane, as FinTech funding has declined by 18% quarter- over-quarter (“QoQ”) in the first quarter of this year, the largest drop in quartlery funding in four years’ time.8 With the boost received during the stay-at-home period

¹https://explodingtopics.com/blog/startup-failure-stats

²https://www.appsflyer.com/infograms/state-of-finance-2021/

³https://firstpagesage.com/seo-blog/seo-roi/average-customer-acquisition-cost-cac-by-industry-b2b-edition-fc/

⁴https://www.appsflyer.com/infograms/2019-app-uninstall-benchmarks/

⁵https://www.appsflyer.com/infograms/2019-app-uninstall-benchmarks/

⁶https://tellimer.com/article/the-fintech-companies-generating-the-highest

⁷https://www.geckoboard.com/best-practice/kpi-examples/ltv-cac-ratio/

⁸https://www.cbinsights.com/research/report/fintech-trends-q1-2022/

of the pandemic dwindling, inflation burning a hole in consumers’ pockets, interest rates rising, a conflict emerging in Europe, and financial markets experiencing a downturn, all these interlinked factors are adding up to turn investors skittish. Hence, the time to course correct by rationalising unit economics is now, as that next round of VC investment may prove to be a bridge too far.

While squeezing more revenue out of customers to increase ARPU is an option, given the inflationary pressures that are already pinching customers’ wallets, rightsizing outlays will have to take place as well. Consequently, as a mad rush to become profitable kicks off, embedded finance can come to the rescue for many of these endangered FinTechs,.

EMBEDDED FINANCE TO THE RESCUE

In layman’s terms, embedded finance is the integration of a financial product / service into a non-financial business’ infrastructure. For instance, say you are surfing an eCommerce website, adding various goods to your online shopping cart; when you arrive at the checkout webpage, you see an option to split your online payment into multiple tranches, that is an instance of embedded lending.

What makes embedded finance such a lucrative proposition is its potential to significantly cut down the CAC that consumer FinTechs directly facing-off against users have to incur. By integrating their solution with a related ecosystem, FinTechs can position themselves ideally for a cross-sell, reducing the need to spend as much on inorganically acquiring customers.

Take the example of digital insurance – despite the advent of digital-only insurers, bancassurance and agent-led sales continue to command the lion’s share of policies sold. This is in part due to insurance schemes, such as health and life, being push and not pull products. Moreover, there is an element of customer education involved as well, which can make the customer acquisition process even more expensive.

However, were these digital insurance products to be integrated in a suitable setting that makes for a natural cross-sell, then they could command a healthy success rate, without the FinTech having to spend as extravagantly on inorganic marketing to woo customers.

Therefore, embedded finance holds the potential to become the panacea for many consumer FinTechs’ exorbitant CACs.

THINGS TO KEEP IN MIND

While it may sound simple enough, formulating a successful embedded finance strategy is easier said than done. Integrating with the wrong partners that do not generate sufficient volumes can result in a costly waste of time, effort, and money.

As such, when putting together their strategic blueprint, FinTechs need to be cognisant of targeting the right business verticals in terms of end customer dynamics and the instinctiveness of the cross-sell in the particular use case scenario involved.

Consequently, when finalising a channel partner, FinTechs should conduct in-depth strategic due diligence of the prospects, to ensure alignment regarding monetary incentivisation of the partner (e.g. revenue split), performance benchmarks for gauging the success / failure of the partnership (e.g. volume-based targets), operational integration (e.g. data and systems synchornisation), the manner in which the product / service will be pushed to the consumer, and much more.

In the meanwhile, as the once rising tide of FinTech continues to recede, many a companies will likely run aground.