Embedded banking: Why the future of finance is in SaaS

Every day we read stories about how banks are being disrupted. While the jury is still out, it is difficult to imagine a future where financial services look unchanged from today.

There are multiple reasons why banks are suddenly vulnerable: technology, regulations, the emergence of a new generation of consumers, all factors that have made it easy for challengers to emerge and bite away increasingly large pieces of a bank’s business.

In the midst of the great unbundling of banking, there is another aspect that gets mentioned less often: A lot of traditional banking functions are being absorbed by software and by the utility they provide. Software is eating banking.

Embedded banking

Businesses use software to perform their job. They use accounting and POS software to keep track of their transactions and maintain an overview of the health of the business. They use human resources tools to store employee details and manage administrative tasks. They use ordering systems and vendor management tools to deal with suppliers. Yet all businesses, small ones in particular, are familiar with the headache of jumping around between the systems they actually use to run their business and their banks or financial service providers.
If only they could perform financial operations directly from their software …

A number of software companies have clearly understood this point and are moving in that direction:

Accounting — Xero, Quickbooks, and other leaders in accounting software already integrate with a large number of banks, allowing businesses to perform most banking operations without leaving these tools. From here, the step is short to becoming the de facto online banking solution of their customers.

POS and payment acceptance — Born as a way to allow small merchants to accept card payments, Square has recently moved more and more into the software space, providing CRM, inventory management, and point of sale solutions. Their vision is now to become “the operating system of the small business,” managing, among other things, cash loans.

Payroll and benefits — Here, Zenefits is the company catching the headlines, but it is not alone. Other players like Justworks and Namely provide powerful SaaS tools, allowing companies to manage their workforce while conveniently accessing benefits and other financial products.

Why it makes sense

Stickiness — The digitalization of banking is eroding banks’ traditional grip on customers, where branches were used as the primary channel to upsell products. Today, most customers can browse different offerings using comparison portals and pick the best choice. Software providers, on the other hand, benefit from the stickiness of adopted workflows and the trove of data that is generated by using them.

Unit economics — Making money out of pure transaction fees is difficult, as the Square story clearly shows. Adding a more predictable revenue stream from subscriptions can help companies reach sustainable economics even at lower volumes. Zenefits has chosen another route for the moment in the pursuit of hyper-growth, but nothing prevents it charging for the value its software provides in the future.

Platform potential — In a world where the fragmentation of financial service providers is the norm, there will eventually be a need for aggregation. By sitting close to the customer and their operations, these software vendors have deep insights into their businesses and are perfectly placed to step in between them and the financial products they need. The real battle will be fought on this ground.

Where to look for disruption

Traditional financial service providers are squeezed between the desire to maintain ownership of customer relations and the demands, from those customers, to open up and facilitate integration with workflow tools. Over time, I expect that they will have to give in and accept that someone else will own that relationship.

For entrepreneurs aspiring to disrupt this sector, I suggest looking beyond improving banking as we have known it so far. The future of banking will probably be found in an unexpected place. Try looking for it in SaaS.

Stefano Zorzi lives in Denmark where he is a partner at Founders, a startup studio based in Copenhagen. Follow him on his blog, Building Squared, or on Twitter @stefanozorzi.