Ahon Sarkar is the General Manager of Helix by Q2, which empowers innovative companies to build personalized BaaS products.
In the last six or seven years, I’ve watched banking as a service (BaaS) evolve from an idea that few understood (and fewer embraced) to one viewed as a magic bullet. Suddenly, everyone seems to be offering embedded financial products.
Unfortunately, some of these products were solutions in search of a problem. They turned out to be more hype than help, and as a result, many weren’t profitable. Now we’re at the point where I hear companies and investors asking if it’s possible to build a profitable embedded banking product.
My answer is yes—with a caveat; instead of trying to build a standalone profitable embedded finance product, I think the goal should be to build a profitable business using BaaS.
From my time heading a company that helps create embedded financial products, I know it can be done, but it’s dependent on three conditions. One is making sure you’re solving an actual problem. The second is catalyzing engagement and usage of other higher-margin activities outside of banking (which is what largely drives long-term profitability). And the third condition is making sure that your technology costs aren’t bringing you underwater and that the tech can scale as you grow—because the real revenue is made at scale.
Solve Actual Problems
If you’re considering launching BaaS products, you need to be crystal clear on the problem or problems you’re solving, the job you’re doing and the core activity you are trying to catalyze. Remember, you want to use BaaS to drive up the usage and profitability of your current business.
Let’s say you’re an insurance company. Your job as an insurance company is to do three things: Get new customers, retain existing customers and make those existing customers more profitable. If you’re going to add BaaS, it better solve at least one of those three objectives; otherwise, it’s a waste of time.
I recently had a leak that destroyed part of my roof, and it took more than three weeks for me to get my disbursement check from my insurance company. It was a horrible, painful experience for me as a customer.
The insurance company’s question should be how to make me more profitable and retain me as a customer. The right embedded banking product could solve both issues. What if the disbursement could be done within ten minutes of the claim being accepted through a virtual wallet or other BaaS product? Now you’ve solved the customer experience problem, I’m thrilled with the process and will likely stay with my insurer. (The company could even give me a slight discount when I renew just for using their virtual wallet for my payout.)
Does it solve the profitability issue, too? Absolutely. With the old model, I’ll spend my disbursement, and the insurance company doesn’t make any money on that transaction. With the embedded banking product, however, the insurance company can earn 1% back on the entire disbursement. With a $10,000 disbursement, the insurance company earns $100 just for facilitating it in a way that makes my life easier and makes me a happier customer.
The insurance company is now increasing profitability on its core products while improving the single biggest problem from a customer experience perspective. Most importantly, the company is effectively lowering its loss ratio.
Catalyzing Engagement And Usage Of Other Higher Margin Activities
Starbucks does a great job of catalyzing engagement through its embedded finance offering. When members order and pay via the app, they get stars and rewards that can be used for future purchases and free items. Starbucks probably makes a little bit of money in paying less processing fees on those transactions (preloading funds and monetizing those deposits), but the real money is being made from their core product: coffee drinks. The app increases its customer base and the amount of coffee each customer buys by making it easier and faster to get to your coffee.
Another way to catalyze engagement on high-margin activities or products is through Save Now, Buy Later (SNBL), a twist on Buy Now, Pay Later (BNPL), where a company incentivizes consumers to save for big-ticket purchases. For example, an airline could offer an SNBL plan whereby users who save for a trip through the airline receive a 5% discount on the eventual trip purchase. Again, the profitability isn’t coming from the savings account. The real profitability comes from the trip purchase and the savings incentive, which increases the number of people who buy trips.
The Right Tech
Your goals with BaaS should be to drive up engagement, lower your costs, increase revenue and decrease fraud—and the fundamental key to all of these is the right tech that will allow you to do all of that at scale.
In order to build a sustainable business, you need a cost-effective model where you have a direct relationship with the bank and the appropriate regulatory controls in place. You also want to be able to personalize your offerings and control fraud.
If you’re already offering BaaS and built on a middleware stack, there’s a good chance you’re dealing with challenges around customer service, regulatory requirements, customizability and scale. As painful as it is, my advice is to transition to a provider that meets the criteria described above that can help you build a more sustainable and profitable business.
Shift Your Thinking
I think that companies that are focused on making a business on interchange alone need to shift their thinking. Making a little money or breaking even on embedded finance is fine, but the ultimate goal should be to solve a challenge of your existing product that gets more people to use it, use it more often, or make it more profitable when they do use it.
Remember, it’s not about making $1 billion on the banking product alone. It’s about making money on your core business more efficiently.
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