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Embedded Finance: Hype vs. Reality
The promise of embedded finance – seamlessly integrating financial services into non-financial platforms – has been buzzing for a while. We're told it's the future, a $185 billion total addressable market (TAM) in North America and Europe alone. But before we crown embedded finance the king, let’s dig into the data and see if the numbers truly support the hype.
One data point immediately jumps out: while the TAM is estimated at $185 billion, current penetration is only around $32 billion. That leaves over 80% of the market "in play," according to Adyen and BCG's research (conducted last year, implying 2024). It’s a huge gap. Is it an opportunity or a reflection of underlying challenges? The answer, as always, lies in the details.
SaaS providers, particularly those offering verticalized solutions, are leading the charge. Over half of relevant independent software vendors in North America are now offering embedded payments. This makes sense. Payments are relatively straightforward to integrate, and the benefits are clear: increased revenue, stickier customers (a 2.5x lower attrition rate compared to non-embedded payments, which is significant), and a more streamlined user experience.
But here's where the narrative gets a bit murkier. The data suggests that moving beyond payments to more complex embedded finance offerings – capital solutions, accounts, card issuing – is proving difficult. SaaS providers are finding it more time-consuming than initially anticipated. This isn’t surprising. Payments are largely commoditized. Lending, on the other hand, requires sophisticated risk management, underwriting, and compliance capabilities.
And this is the part of the report that I find genuinely puzzling. While SaaS providers are encouraged to outsource underwriting to embedded lending partners initially, they’re also advised to perform "thorough oversight" of these partners. Seems like a potentially tricky balancing act. How can a SaaS company, whose core competency is software, effectively oversee the risk models and credit teams of a specialized lending firm? It's like asking a chef to audit an electrician.
The report also highlights the importance of tailoring embedded finance products to specific industries, SME demographics, and platform data. Makes sense, right? A restaurant's financing needs are different from a construction company's. But then we see that single-digit percentage of merchants consistently use software finance products like cash advances. Single-digit? That's not exactly a ringing endorsement.
The Merchant Perspective
The report touches on a critical factor often overlooked in the rush to embrace new technologies: merchant satisfaction with existing solutions. Many SMEs are content with their current banking relationships and don't see a compelling reason to switch to embedded finance. Banks, after all, have been masters of product bundling and pricing for decades. They know how to keep their customers happy (or at least, not unhappy enough to switch).
This brings us to the crucial question: is embedded finance truly solving a pain point for SMEs, or is it simply a solution in search of a problem? Are we seeing genuine demand, or is it being artificially inflated by the SaaS providers eager to boost their revenue and valuation?
To succeed, SaaS providers need to nail product-market fit, develop effective go-to-market strategies (bundling/pricing, targeted outreach), and thoughtfully design and scale their capabilities. Easier said than done. It's not enough to simply bolt on financial services to an existing software platform. It requires a deep understanding of the target market, a compelling value proposition, and a seamless user experience.
The SME adoption of vertical software in the US reached 59% in 2024, compared to 50% in 2022. That's solid growth (about 9 percentage points in two years—to be more exact, 9 percentage points). This growing reliance on vertical software creates an opportunity for embedded finance. But it also raises the stakes. If these solutions are poorly designed or fail to deliver tangible value, it could erode trust in the entire ecosystem.
The Verdict: Cautious Optimism
Embedded finance has potential, no doubt. But the data suggests that the path to widespread adoption is not as smooth as some might believe. The challenges are real, the competition is fierce, and the needs of SMEs are complex. Success will require a laser focus on product-market fit, a willingness to experiment and iterate, and a healthy dose of realism.