Digital transformation — platform model — embedded finance

The trend of digital transformation is platform model with embedded finance

Angela Strange from A16z said all company will be a fintech, For a fintech nerd, I initially thought, oh great, finally fintech chance to shine. But then I began to wonder will fintech really be that great? What about other great technologies like AI? Then, I realized that the next wave of digital transformation lies in embedded finance, and here is how.

For this article, I will focus on digital transformation model. If interested in the semantics and how to, refer to my previous articles: part1, part2.

How digital transformation has evolved?

First, let’s see how digital transformation has evolved with the platform technology. As Matt Harris from Bain capital venture has pointed out, the platform technology evolved from internet (connectivity) -> cloud (intelligence) -> mobile (ubiquity) -> to fintech.

Many businesses took advantage of these phases in the evolution, and created new and powerful giants. Creating new business is one of the most exciting and challenging part of digital transformation as I have pointed out in previous article. Facebook, Google, and Amazon leveraged the internet. Salesforce and AWS leveraged cloud; Apple, or more specifically iPhone, and Uber leveraged mobile.

Each of these businesses had “transformative” impacts. Amazon changed how we shop. Google changed how we find information. Facebook changed how we stay connected with others. Salesforce and AWS changed how software is delivered and updated. Uber changed the way we travel. iPhone & AppStore changed “about everything” according to Steve Jobs on January 9th 2007 when he introduced iPhone to the world.

Instead of what the great Matt Harris calls fintech, I believe the next wave of digital transformation is platform, or the platform model.

Digital transformation model: platform

By platform model, I mean a business model that leverages the innovations and resources of third parties to create enormous value for the customers instead of only relying on the functionalities of own product. Basically, building a moat by meeting all the needs of your users, so they don’t need to go somewhere else to complete a service. In today’s world, more engagement leads to more data points, and leads to more revenue opportunity. (The moat is referred to Warren Buffett’s investment principle)

For example, Amazon partnered with Goldman Sachs to offer financing to its sellers 06/2020. Shopfiy partnered with Stripe, and has already made $500 million per annum from offering financial services to its merchants with 50% yoy growth rate. Both are able to do so at a low cost since they already have lots of data on their users. The benefits are pretty clear:

• For the platform: keeps the users within its eco-system, acquires important user data, and creates additional source of revenue.
• For users: Convenience of getting service when needed without going through different places.

As businesses compete for eye balls and user engagements, it becomes more and more important to drive toward the platform model. The platform model is aimed to keep users within their system. More engagements -> more user data points -> more ideas on improving user experience -> more revenue opportunities. This becomes a positive cycle that helps businesses differentiate on highly commoditized digital channels.

Platform model components

Within the platform model, we typically see three types of roles:

1. Market place, platform, or eco-system
2. Infrastructure, enabler
3. Specialized service provider

Note: they are not mutually exclusive. For example DoorDash, the popular food delivery app is expanding to offer more services such as grocery and drug store delivery (type 1). It’s also white labeling its delivery service to Walmart ( type 2).

For incumbents to build out the platform, a popular place to start has been finance, or labeled embedded finance.

What is embedded finance & why?

Embedded finance refers to non-financial companies that have value propositions that are significantly enhanced or even transformed through the associated financial products and services embedded within.

Though not limited to embedded finance, but it’s a good place to start because:

• A number of financial API companies have emerged that lowered the threshold to entry. Including financial products went from years and teams to days and 5 lines of code.
• Good source of revenue.
• Obtain important user data, such as transaction history.

Basically, the platform model keeps the users within a business, then embedded finance provides a way for the business to monetize its user traffic while getting important transactional data. This is also how platforms build their moat.

On a side note, it’s interesting to note how embedded finance is applied in different countries. In US, the separation of roles I have outlined above is more clear compared to countries like China. For example in US, Toast for restaurants, Veena for pharma, Servicetitan for field service, and Shopify for B2B commerce all leveraged third parties to embed financial functions. In China, PingAn, the insurance conglomerate, is planning to create its own eco-system and infrastructure in the following verticals: finance, auto, smart city, healthcare, and real estate. I suspect that as developing countries leapfrog, we will see more of such model.

Conclusion

The next wave of digital transformation has already begun with the platform model with embedded finance. This combination keeps the user within its own system while generate revenue and collect important data. This is why embedded finance has been a good place to start, but certainly not the only one.