The U.S. has lagged behind other countries in the widespread adoption of financial innovations like open banking and digital assets. However, in the world of embedded finance—where financial products are integrated into non-bank software—the United States is leading the way.
According to a report from PSE Consulting and The Strawhecker Group (TSG), a third of small to medium-sized businesses in the U.S. use embedded finance services provided through software-as-a-service companies. In comparison, only 11% of smaller businesses in the UK and 6% in Germany and France use these services.
The study found that European merchants weren’t averse to SaaS solutions, but that the software companies in the region weren’t able to pique merchants’ interest with their current embedded finance solutions.
“The number of small businesses in the U.S. who have adopted embedded finance is even higher, according to a recent survey by Javelin’s small business practice,” said Don Apgar, Director of Merchant Payments at Javelin Strategy & Research. “That research indicates that roughly half of U.S. merchants no longer obtain a business account from their bank. They are increasingly turning to their technology provider.”
No Business Too Small
In the past, a merchant’s point-of-sale system required multiple computers interconnected to form an internal server. This setup meant that a company needed substantial revenue to justify spending thousands of dollars on a payments system.
However, with the customer integrated system (CIS) model, merchants don’t require installed software to operate their business. They can purchase a monthly subscription from a SaaS provider and process payments through a tablet or device.
“It has made it much more accessible for businesses, and now there’s no such thing as a business too small to have software,” Apgar said. “That’s one of the differences between the U.S. and Europe. There has been a substantial focus on technology in the U.S., and companies like Square, Shopify, and Toast have made embedded finance technology affordable.”
Though the tech might not be ubiquitous, merchants worldwide have overwhelmingly indicated they would prefer to transition away from traditional payments processors to software platforms. The PCE and TSG study found approximately 70% of small to medium-sized businesses in the EU and the U.S. said they would choose a software platform the next time they select a payments supplier.
Beyond Embedded Payments
In Europe, embedded finance still mostly refers to payments processing within a software platform. In the U.S., software companies are moving beyond payments to incorporate a range of financial products.
“Point-of-sale companies like Toast are already offering additional solutions like business checking accounts,” Apgar said. “Embedded lending is gaining traction, as companies like Square already offer business loans to merchants. Players like Shopify, Toast, and Lightspeed are driving significant revenue from embedded finance, and they are constantly looking for new products they can bundle.”
One of the most powerful benefits embedded finance offers merchants is the ability to centralize accounting functions. As SaaS platforms include more financial aspects, they have the potential to be the central hub for all of an organization’s financial needs.
Small businesses have access to more data than ever before, but it often comes from disparate sources. They may pay a monthly SaaS subscription for tools to manage inventory and process credit and debit card payments. In addition, small businesses require a checking account, and the ability to receive and pay invoices from suppliers. They also need to manage employee payroll and benefits.
Most small businesses invest substantial time and money hiring accounting services to align all these data sources. If a merchant can reconcile all those functions in one place and with minimal effort, it could have a dramatic impact.
Managing all the accounting can be a major time drain. Even if a CPA is handling it, they will still need guidance on certain aspects since they don’t have in-depth knowledge of the business’ operations. The scarcest resource for small business owners today is time. By connecting all the data sources and uses, much of the manual work can be eliminated.
The Technology Intersection
As software companies take on more financial functions for merchants, the role of financial institutions in the business banking process has been diminished. However, the model has created an opportunity for banks to use software companies as distribution partners.
Financial institutions can embed their services directly into a merchant’s point-of-sale application to attract more customers.
“Fintech is the intersection of finance and technology, and software companies are actively looking for ways to disintermediate banks out of the financial chain,” Apgar said. “If half of merchants no longer go to a bank to open their merchant account, that’s significant. If software companies are already handling payments processing, it makes sense that banks should partner with these providers.”
